Today, we’ll introduce the concept of the P/E ratio for those who are learning about investing. We’ll look at Synthomer plc’s (LON:SYNT) P/E ratio and reflect on what it tells us about the company’s share price. Looking at earnings over the last twelve months, Synthomer has a P/E ratio of 15.53. In other words, at today’s prices, investors are paying £15.53 for every £1 in prior year profit.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Synthomer:
P/E of 15.53 = GBP3.41 ÷ GBP0.22 (Based on the trailing twelve months to June 2019.)
Is A High Price-to-Earnings Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That isn’t necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
Does Synthomer Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Synthomer has a lower P/E than the average (22.9) P/E for companies in the chemicals industry.
Its relatively low P/E ratio indicates that Synthomer shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Synthomer, it’s quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
How Growth Rates Impact P/E Ratios
When earnings fall, the ‘E’ decreases, over time. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. Then, a higher P/E might scare off shareholders, pushing the share price down.
Synthomer’s earnings per share fell by 27% in the last twelve months. But over the longer term (5 years) earnings per share have increased by 10%. And EPS is down 1.8% a year, over the last 3 years. This could justify a low P/E.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
So What Does Synthomer’s Balance Sheet Tell Us?
Synthomer’s net debt is 16% of its market cap. That’s enough debt to impact the P/E ratio a little; so keep it in mind if you’re comparing it to companies without debt.
The Verdict On Synthomer’s P/E Ratio
Synthomer trades on a P/E ratio of 15.5, which is below the GB market average of 18.5. Since it only carries a modest debt load, it’s likely the low expectations implied by the P/E ratio arise from the lack of recent earnings growth.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than Synthomer. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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